What is the reduced cost base?

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When a CGT event happens to a CGT asset and you haven’t made a capital gain, you need the asset’s reduced cost base to work out whether you have made a capital loss. Remember, you can use a capital loss to reduce a capital gain only, you cannot use it to reduce other income.

Elements of the reduced cost base

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element:

money or property given for the asset

incidental costs of acquiring the CGT asset or that relate to the CGT event

balancing adjustment amount, that is, any amount that is assessable because of a balancing adjustment for the asset or that would be assessable if certain balancing adjustment relief were not available

capital costs to increase or preserve the value of your asset or to install or move it

capital costs of preserving or defending your title or rights to your asset.

These elements are not indexed.

You need to work out the amount for each element then add the amounts together to find out your reduced cost base for the relevant CGT asset.

If you are registered for GST, you reduce each element of the reduced cost base of the asset by the amount of any GST net input tax credits for that element. If you are not registered for GST, you do not make any adjustment and the GST paid is included in the reduced cost base.

The reduced cost base does not include any costs you have incurred for which you have claimed a tax deduction or have omitted to claim, but can still claim, a deduction because the period for amending the relevant income tax assessment has not expired, for example, capital works deductions for capital expenditure.

Example 5: Capital works deduction: effect on reduced cost base

Danuta acquired a new income-producing asset on 28 September 2005 for $100,000. She sold it for $90,000 in November 2014. During the period she owned it, she claimed capital works deductions of $7,500. Her capital loss is worked out as follows:

Cost base

$100,000

less capital works deductions

$7,500

Reduced cost base

$92,500

less capital proceeds

$90,000

Capital loss

$2,500

End of example

Modifications to the cost base and reduced cost base

In some cases, the general rules for calculating the cost base and reduced cost base have to be modified. For example, you substitute the market value for the first element of the cost base and reduced cost base if:

you did not incur expenditure to acquire the asset

some or all of the expenditure you incurred cannot be valued

you did not deal at arm’s length with the previous owner in acquiring the asset.

This is known as the market value substitution rule for cost base and reduced cost base.

There are exceptions to the market value substitution rule. One exception is where shares in a company, or units in a unit trust, are issued or allotted to you but you did not pay anything for them.

You do not include expenditure you subsequently recoup (such as an insurance pay-out you receive or an amount paid for by someone else) in the cost base and reduced cost of a CGT asset except to the extent the recouped amount is included in your assessable income.

Example 6: Recouped expenditure

John bought a building in 2000 for $200,000 and incurred $10,000 in legal costs associated with the purchase. As part of a settlement, the vendor agreed to pay $4,000 of the legal costs. John did not claim as a tax deduction any part of the $6,000 he paid in legal costs.

He later sells the building. As he received reimbursement of $4,000 of the legal costs, in working out his capital gain, he includes only the $6,000 he incurred in the cost base.

End of example

If you acquire a CGT asset and only part of the expenditure relates to the acquisition of the CGT asset, you can only include that part of the expenditure that is reasonably attributable to the acquisition of the asset in its cost base and reduced cost base.

Apportionment is also required if you incur expenditure and only part of that expenditure relates to another element of the cost base and reduced cost base.

Similarly, if a CGT event happens only to part of your CGT asset, you generally apportion the asset’s cost base and reduced cost base to work out the capital gain or capital loss from the CGT event.

Consolidated groups

The rules that apply to members of a consolidated group modify the application of the CGT rules.

General value shifting regime

Value shifting generally occurs when a dealing or transaction between two parties is not at market value and results in the value of one asset decreasing and (usually) the value of another asset increasing.

The general value shifting regime (GVSR) rules apply to value shifts that arise:

because interests in a company or trust are issued or bought back at other than market value, or because their rights are varied so that the value of some interests increases while the value of others decreases (direct value shifts on interests)

because two entities under the same control or ownership conduct dealings or transactions that are neither at market value nor arm’s length, so that the value of interests in one entity decreases while (usually) the value of interests in the other entity increases (indirect value shifting), and

from the creation of a right over a non-depreciating asset in favour of an associate for less than market value (direct value shifts by creating rights).

The rules on direct value shifts on interests target only equity or loan interests held by an individual or entity that controls the company or trust, the controller’s associates and, if the company or trust is closely held, any active participants in the arrangement.

The indirect value shifting rules target only equity or loan interests held by an individual or entity that controls the two entities conducting the dealing or transaction and the controller’s associates. But if the two entities are closely held, the rules also target equity or loan interests held by two or more common owners of those entities, the common owner’s associates and any active participants in the arrangement.

There are also exclusions and safe harbours that limit the operation of the rules.

If the rules apply, you may need to adjust:

the cost base and reduced cost base of equity and loan interests affected by the value shift, or

Debt forgiveness

A debt is forgiven if you are freed from the obligation to pay it. Commercial debt forgiveness rules apply to debts forgiven after 27 June 1996. A debt is a commercial debt if part or all of the interest payable on the debt is, or would be, an allowable deduction.

Under the commercial debt forgiveness rules, a forgiven amount may reduce (in the following order) your:

prior income year revenue losses

net capital losses from earlier years

deductions for capital allowances and some similar deductions

assets’ cost base and reduced cost base.

These rules do not apply if the debt is forgiven:

as a result of an action under bankruptcy law

in a deceased person’s will, or

for reasons of natural love and affection.

Example 7: Applying a forgiven debt

On 1 July 2014, Josef had available net capital losses from earlier years of $9,000. On 3 January 2015, he sold shares he had owned for more than 12 months for $20,000. They had a cost base (no indexation) of $7,500. On 1 April 2015, a commercial debt of $15,000 that Josef owed to AZC Pty Ltd was forgiven. Josef had no prior income year revenue losses and no deductible capital expenditure.

Josef must use part of the forgiven commercial debt amount to wipe out his net capital losses from earlier years and the rest to reduce the cost base of his shares. He works out the amount of net capital gain to include in his assessable income as follows:

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